Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues: A corporation invests $50 million in a foreign subsidiary. The subsidiary records the contribution from the corporation as contributed surplus in the shareholder equity section of its balance sheet. The corporation records the amount on its balance sheet as an investment in subsidiary for the full amount. May the corporation claim an investment allowance for the full amount of the investment in the subsidiary?
Position: It may claim an investment allowance for the full amount of the investment.
Reasons: Subsection 181.2(4) provides for an investment allowance for shares held in another corporation. No investment allowance is expressed in respect of contributed surplus. Subsection 181(3) provides that the relevant amounts to be used in assessing investment allowance is the carrying value of that amount on the balance sheet. In this case, it must be determined whether the balance sheet amount "investment in subsidiary" represents a pooled account, being the aggregate of the value of shares with the value of contributed surplus, or whether it represents only the value of shares, with the parent's contributed surplus being a factor attributed to the share value under GAAP. In the former case, the CCRA's position would have been that the underlying balances would have to be examined, with only the value of shares included in the investment allowance. However, our understanding is that, under GAAP, the full amount of the investment account reflects the value attributed to the shares. Although it is a fine distinction, we view this as a different situation from that where GAAP characterizes an amount as something different than what it is law for e.g., where GAAP characterizes earned income as unearned income or where GAAP characterizes an asset that is leased as an asset that is owned. In this case, GAAP is not, as we understand it, recharacterizing contributed surplus as shares; rather, it attributes the value of the parent's investment to its shares.
Question 3:
Canco is a Canadian corporation operating in Canada and is subject to Large Corporations Tax ("LCT"). Canco owns all of the issued common stock of Forco, which is a foreign affiliate. Forco is neither resident in Canada at any time in the year, nor does it carry on business through a permanent establishment in Canada at any time in the year, and is therefore exempt from the application of LCT. Canco borrows $50 million from a Canadian bank and invests it in Forco. Forco records the contribution from Canco as contributed surplus in the shareholder equity section of its balance sheet. Canco will include the $50 million bank loan in its LCT calculation under paragraph 181.2(3)(c) of the Income Tax Act. Canco's financial statements carry an investment in Forco of $50,020,000. Forco's financial statement indicate that Canco has an investment in Forco of common stock of $20,000 and contributed surplus of $50,000,000.
Will Canco's investment in Forco, as either common stock or contributed surplus, qualify as part of Canco's investment allowance for purposes of the LCT?
Answer:
Canco may claim an investment allowance in respect of the entire investment in Forco.
The investment allowance of a corporation, other than a financial institution, is defined in subsection 181.2(4). Pursuant to that subsection, Canco would generally be permitted to claim an investment allowance for shares that it holds in other corporations. However, if the other corporation is exempt from the LCT, no investment allowance may be claimed unless that corporation was so exempt solely because it was not resident in Canada at any time in the year, nor carrying on business through a permanent establishment in Canada at any time in the year. As Forco is exempt from the LCT solely because it was not resident in Canada nor carrying on business through a permanent establishment at any time in the year, Canco may claim an investment allowance in respect of the shares it holds in Forco.
Subsection 181.2(4) does not include, in a corporation's investment allowance, the amount of its contributed surplus in another corporation. Therefore, it must be determined whether the balance sheet amount "investment in subsidiary" represents a pooled account, representing two separate amounts, the value of the parent's investment in shares and the value of the parent's investment in contributed surplus, or whether it represents only the value of the parent's investment in shares, with the parent's contributed surplus being a relevant factor in valuing the shares in accordance with GAAP. In the former case, the CCRA's position would have been that the underlying balances must be examined, with only the value of shares included in the investment allowance. However, our understanding is that, under GAAP, the full amount of the account "ínvestment in subsidiary" reflects the value attributed to the shares.
Although it is a fine distinction, we view this as a different situation from that where GAAP characterizes an amount as something different than what it is at law, for e.g., where GAAP characterizes earned income as unearned income or where GAAP characterizes an asset that is leased as an asset that is owned. The CCRA's position is that the legal characterization of an amount governs its capital tax treatment. Our understanding in this type of case is that GAAP does not recharacterize contributed surplus as shares i.e. the parent is not viewed as having subscribed for shares by having contributed surplus. Rather, GAAP views the contribution of surplus as having enhanced the value of the shares held by the parent.
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